As for Tyler’s (and others’) call for monetary policy instead of fiscal
policy, here’s the problem. It relies upon changing expectations of future
inflation (which changes the real interest rate). You have to get people to
believe that the Fed will actually be willing to create inflation in the future
when it comes time to do so. However, it’s unlikely that it will be optimal for
the Fed to cause inflation when the time comes. Because of that, the best policy
is to promise that you’ll create inflation, then renege on the promise when it
comes time to follow through. Since people know that, and expect the Fed will
not actually carry through, it’s hard to get them to change their expectations
now. All that credibility the Fed has built up and protected concerning their
inflation fighting credentials works against them here.

Paul Krugman developed the idea of an expectations trap as a way of
explaining the dilemma faced by the Bank of Japan. Except there is just
one problem. Almost everyone agrees that Japan does not face an
expectations trap. They can devalue the yen whenever they wish, as much as
they wish. ...

But here’s the bigger flaw with the whole expectations trap argument.
People think it applies to monetary policy, but they forget it applies equally
to fiscal policy. (Indeed I never realized this until today.) Here’s why.
Krugman’s model relies on rational expectations, indeed you can’t get the
expectations trap without ratex. But if you have ratex in your model, then
no policy can work unless it is expected to work. ...

This is relatively easy to dispense with. First, those of us who pushed for
fiscal policy were told we were basing this on old-fashioned models, IS-LM at
best, maybe even more outdated than that. So the New Keynesian theorists went to
work and showed that within the modern models used for policy analysis, fiscal
policy does, in fact, find support.

The model I've been using in particular is
Eggertsson's and to some extent
Woodford's. The
difference is that Eggertsson looks at how multipliers vary across various tax
and government spending policies, while Woodford is more concerned with the
determinants of the size of the government spending multiplier. For example, Woodford says:

Much public discussion of this issue has been based on old-fashioned models
(both Keynesian and anti-Keynesian) that take little account of the role of
intertemporal optimization and expectations in the determination of aggregate
economic activity. Yet discussions of monetary stabilization policy over the
past several decades have been transformed by the development of a new
generation of macroeconomic models that simultaneously consider the dynamic
implications of intertemporal optimization on the one hand, and delays in the
adjustment of wages and prices on the other. The implications of these models
for fiscal stabilization policy have been much less fully developed than their
implications for monetary policy. But this is not because the models do not have
implications for fiscal policy. The present paper reviews some of these
implications for one specific question of current interest: the determinants of
the size of the effect on aggregate output of an increase in government
purchases, or what has been known since Keynes (1936) as the government
expenditure "multiplier."

Going back to the creditability issue raised by Scott Sumner, one of the points
that Eggertsson makes is that government spending does not have the credibility
problem that plagues monetary policy. He
says:

As shown by several authors, such as Eggertsson and Woodford (2003) and Auerbach
and Obstfeld (2005), it is only the expectation about future money supply (once
the zero bound is no longer binding) that matters ... when the interest rate is
zero. ... Expansionary monetary policy can be difficult if the central bank
cannot commit to future policy. The problem is that an inflation promise is not
credible for a discretionary policy maker. ...

This credibility problem is what Eggertsson (2006) calls the "deflation bias" of
discretionary monetary policy at zero interest rates. Government spending does
not have this problem. ... The intuition is that fiscal policy not only requires
promises about what the government will do in the future, but also involves
direct actions today. And those actions are fully consistent with those the
government promises in the future (namely, increasing government spending
throughout the recession period). ...

Even so, monetary policy might still work, it's a matter of
being able to credibly commit to future inflation:

It seems quite likely that, in practice, a central bank with a high degree of
credibility, can make credible announcements about its future policy and thereby
have considerable effect on expectations. Moreover, many authors have analyzed
explicit steps, such as expanding the central bank balance sheet through
purchases of various assets such as foreign exchange, mortgage-backed
securities, or equities, that can help make an inflationary pledge more credible
(see, e.g., Eggertsson (2006), who shows this in the context of an optimizing
government, and Jeanne and Svensson (2004), who extend the analysis to show
formally that an independent central bank that cares about its balance sheet can
also use real asset purchases as a commitment device). Finally, if the
government accumulates large amounts of nominal debt, this, too, can be helpful
in making an inflation pledge credible. However, the assumption of no credible
commitment by the central bank, as implied by the benchmark policy rule here, is
a useful benchmark for studying the usefulness of fiscal policy.

I think the assumption that the Fed cannot credibly commit to future inflation is a relevant benchmark in the present case since I am not sure that
people believe that the government will actually create inflation in the future
even if they promise to do so now. As I said in the original post, I think the
inflation fighting credential the Fed has worked so hard to earn work against
them in this instance. My point was that I didn't want to put all of my faith in
one policy instrument -- monetary policy -- when theory and experience says that
fiscal policy is the superior policy tool at the zero bound. Monetary policy
alone might work, but again, if fiscal policy is available and these
uncertainties exist, why take a chance? Why not use fiscal policy as well?

More generally, if people want to go back and use older or different models to make their arguments, that
is fine, but it doesn't have a lot to do with the argument I was making. Perhaps
they believe these models are superior to the models that
Woodford and Eggertsson are using, that's certainly their prerogative, but which
model provides better answers to the questions we are asking is a completely
different argument. For the most part, the issues being raised about credibility have been considered and addressed within the New Keynesian framework.

As for Tyler’s (and others’) call for monetary policy instead of fiscal
policy, here’s the problem. It relies upon changing expectations of future
inflation (which changes the real interest rate). You have to get people to
believe that the Fed will actually be willing to create inflation in the future
when it comes time to do so. However, it’s unlikely that it will be optimal for
the Fed to cause inflation when the time comes. Because of that, the best policy
is to promise that you’ll create inflation, then renege on the promise when it
comes time to follow through. Since people know that, and expect the Fed will
not actually carry through, it’s hard to get them to change their expectations
now. All that credibility the Fed has built up and protected concerning their
inflation fighting credentials works against them here.

Paul Krugman developed the idea of an expectations trap as a way of
explaining the dilemma faced by the Bank of Japan. Except there is just
one problem. Almost everyone agrees that Japan does not face an
expectations trap. They can devalue the yen whenever they wish, as much as
they wish. ...

But here’s the bigger flaw with the whole expectations trap argument.
People think it applies to monetary policy, but they forget it applies equally
to fiscal policy. (Indeed I never realized this until today.) Here’s why.
Krugman’s model relies on rational expectations, indeed you can’t get the
expectations trap without ratex. But if you have ratex in your model, then
no policy can work unless it is expected to work. ...

This is relatively easy to dispense with. First, those of us who pushed for
fiscal policy were told we were basing this on old-fashioned models, IS-LM at
best, maybe even more outdated than that. So the New Keynesian theorists went to
work and showed that within the modern models used for policy analysis, fiscal
policy does, in fact, find support.

The model I've been using in particular is
Eggertsson's and to some extent
Woodford's. The
difference is that Eggertsson looks at how multipliers vary across various tax
and government spending policies, while Woodford is more concerned with the
determinants of the size of the government spending multiplier. For example, Woodford says:

Much public discussion of this issue has been based on old-fashioned models
(both Keynesian and anti-Keynesian) that take little account of the role of
intertemporal optimization and expectations in the determination of aggregate
economic activity. Yet discussions of monetary stabilization policy over the
past several decades have been transformed by the development of a new
generation of macroeconomic models that simultaneously consider the dynamic
implications of intertemporal optimization on the one hand, and delays in the
adjustment of wages and prices on the other. The implications of these models
for fiscal stabilization policy have been much less fully developed than their
implications for monetary policy. But this is not because the models do not have
implications for fiscal policy. The present paper reviews some of these
implications for one specific question of current interest: the determinants of
the size of the effect on aggregate output of an increase in government
purchases, or what has been known since Keynes (1936) as the government
expenditure "multiplier."

Going back to the creditability issue raised by Scott Sumner, one of the points
that Eggertsson makes is that government spending does not have the credibility
problem that plagues monetary policy. He
says:

As shown by several authors, such as Eggertsson and Woodford (2003) and Auerbach
and Obstfeld (2005), it is only the expectation about future money supply (once
the zero bound is no longer binding) that matters ... when the interest rate is
zero. ... Expansionary monetary policy can be difficult if the central bank
cannot commit to future policy. The problem is that an inflation promise is not
credible for a discretionary policy maker. ...

This credibility problem is what Eggertsson (2006) calls the "deflation bias" of
discretionary monetary policy at zero interest rates. Government spending does
not have this problem. ... The intuition is that fiscal policy not only requires
promises about what the government will do in the future, but also involves
direct actions today. And those actions are fully consistent with those the
government promises in the future (namely, increasing government spending
throughout the recession period). ...

Even so, monetary policy might still work, it's a matter of
being able to credibly commit to future inflation:

It seems quite likely that, in practice, a central bank with a high degree of
credibility, can make credible announcements about its future policy and thereby
have considerable effect on expectations. Moreover, many authors have analyzed
explicit steps, such as expanding the central bank balance sheet through
purchases of various assets such as foreign exchange, mortgage-backed
securities, or equities, that can help make an inflationary pledge more credible
(see, e.g., Eggertsson (2006), who shows this in the context of an optimizing
government, and Jeanne and Svensson (2004), who extend the analysis to show
formally that an independent central bank that cares about its balance sheet can
also use real asset purchases as a commitment device). Finally, if the
government accumulates large amounts of nominal debt, this, too, can be helpful
in making an inflation pledge credible. However, the assumption of no credible
commitment by the central bank, as implied by the benchmark policy rule here, is
a useful benchmark for studying the usefulness of fiscal policy.

I think the assumption that the Fed cannot credibly commit to future inflation is a relevant benchmark in the present case since I am not sure that
people believe that the government will actually create inflation in the future
even if they promise to do so now. As I said in the original post, I think the
inflation fighting credential the Fed has worked so hard to earn work against
them in this instance. My point was that I didn't want to put all of my faith in
one policy instrument -- monetary policy -- when theory and experience says that
fiscal policy is the superior policy tool at the zero bound. Monetary policy
alone might work, but again, if fiscal policy is available and these
uncertainties exist, why take a chance? Why not use fiscal policy as well?

More generally, if people want to go back and use older or different models to make their arguments, that
is fine, but it doesn't have a lot to do with the argument I was making. Perhaps
they believe these models are superior to the models that
Woodford and Eggertsson are using, that's certainly their prerogative, but which
model provides better answers to the questions we are asking is a completely
different argument. For the most part, the issues being raised about credibility have been considered and addressed within the New Keynesian framework.